High-Speed Trading, Fragmentation Silver Lining to Market Glitches

By Wall Street FOXBusiness

First there was the Flash Crash in May 2010, the day computers-gone-awry caused U.S. stock markets to collapse in a matter of minutes, only to recover just as quickly.

Continue Reading Below

Two years later in May 2012 Facebook’s (NASDAQ: FB) very high-profile IPO was marred by a buggy computer system. And not long after that in August 2012 the Knight Capital Group lost hundreds of millions of dollars in the blink of an eye to a malfunctioning computer program, a glitch that eventually put the firm as we knew it out of business.

In 2013 the Nasdaq (NDAQ) market closed temporarily due to a system breakdown and, most recently the New York Stock Exchange, owned by InterContinental Exchange (ICE), was forced to shutter trading for over three hours last week apparently while testing new software.

Two points remain clear in the wake of the most recent glitch: securities trading will continue to migrate to computers regardless of the past hiccups, and the computers will continue to go on the fritz occasionally.

But rather than condemn an increasingly automated trading system that plays out at high-speed across an array of fragmented markets, experts say the swift recovery from each of these glitches, in particular the shutdown last week at the NYSE, is proof of the sustained -- and even increasing -- resiliency of U.S. markets.

Fragmentation Saved the Day

Continue Reading Below

In recent years, not least following the publication last year of Michael Lewis’ “Flash Boys,” an outspoken segment of investors and analysts have complained that fragmentation among the exchanges has increased the likelihood of such glitches and allowed so-called high-frequency traders (Lewis’ “Flash Boys”) to exploit vulnerabilities created by fragmentation.

But fragmentation helped save the day last week.

Fragmentation, according to Jaret Seiberg, an analyst at Guggenheim Securities, “means there is still robust trading even when a major exchange experiences a technical glitch. To us, this makes it harder to fight against.”

“This is negative for those who complain that market fragmentation is hurting liquidity and small investors,” Seiberg wrote in a research note.

Initially, the NYSE shutdown was feared to have been caused by a hacker, a situation that would have rightfully shaken markets around the world. But the NYSE quickly put that fear to rest, blaming it on malfunctioning software.

Nevertheless, because it was the venerable NYSE that was mysteriously halted, the shutdown caused widespread anxiety in the midst of an otherwise normal trading day, in particular among analysts and the media. (Professional traders for the most part seemed well aware of the various exchange alternatives available to them.)

Barely Disrupted Broader Markets

As the hours passed it became clearer that the disruption at the NYSE barely disrupted the broader markets.

“Clearly, when the markets went down a lot of people were surprised that there are a lot of other markets that trade the same stocks as the New York Stock Exchange,” said Bill Harts, chief executive officer of Modern Markets Initiative, an industry group that supports high-frequency trading.

Indeed, when trading halted last week on the Big Board traders simply redirected their trades to one of 10 or so other registered exchanges available to them, or one of roughly 40 “dark pools” operated by financial firms such as Goldman Sachs (GS) and Credit Suisse (CS).

“All of these other markets continued to trade just fine,” Harts added. “Literally billions of shares continued to trade without a hiccup.”

The argument against fragmentation and high-frequency trading (HFT) has been that rogue traders armed with sophisticated computers and complex algorithms are able to leverage their technology and exploit the new landscape at the expense of average investors.

Lewis and other HFT critics say the practice is used (or misused) to skim billions of dollars in profits out of the markets that would otherwise go into the retirement accounts of average mom and pop investors.

Never Knew the Difference

Advocates for high-speed trading have countered that computers have in fact leveled the playing fields for all investors and dramatically lowered costs by improving market liquidity which narrows the price spreads between bids and offers.

Harts described the current investing landscape as an ecosystem that includes the array of exchanges and dark pool, brokers and various market makers including high-frequency traders.

Because high–frequency trading provides liquidity across all these varied markets, if one market fails like it did last week trades can easily move to another market and expect to find similar levels of liquidity, Harts explained.

“And that’s exactly what happened that day,” he said. “Investors never even knew the difference.”

What do you think?

Click the button below to comment on this article.